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The
Tax Court held that the amount of tax shown on the taxpayers’
return was reduced by refundable credits, but not below zero,
for purposes of calculating the Sec. 6662(a) accuracy-related
penalty (Rand, 141 T.C. No. 12 (2013)).
The court reached that conclusion even though the taxpayers
were not entitled to the credits they had claimed.

The
taxpayers had filed returns for 2006, 2007, and 2008 for which
the IRS sent notices of deficiency. The issues arising in the
2006 and 2007 tax years were settled by stipulation and only
the issues arising in 2008 year were before the Tax Court. The
taxpayers had claimed an earned income tax credit (EITC) and
an additional child tax credit to which they agreed they were
not entitled. The issue before the court was how to determine
the “amount of tax required to be shown on [the] return,” for
purposes of applying the 20% Sec. 6662(a) penalty.

The
taxpayers reported $18,148 of income on the return, including
the wife’s $1,020 of income from self-employment as a tutor.
Deducting the $10,900 standard deduction and $14,000 of
personal exemptions reduced their taxable income to $0. They
showed a tax on their return of $144 for the wife’s
self-employment tax.

The taxpayers argued that the 20%
penalty should be applied to the $144 of tax, but the IRS
claimed that the penalty should apply to the full amount of
the taxpayer’s deficiency, including the disallowed refundable
credits, so that the base for the penalty was $8,127,
resulting in a Sec. 6662(a) penalty of $1,625.

The Tax
Court, however, came up with its own interpretation. The tax
shown on the return, the Tax Court concluded, should be
reduced by the credits at issue in this case, but not below
$0. The phrase “tax shown on a return” occurs in the Code
three times, the court explained, and it examined Sec.
6211(b), “Definition of a deficiency,” which defines the tax
shown on a return as excluding certain credits. Because the
specific credits in Sec. 6211(b) that are to be excluded did
not include the EITC or the child tax credit, the court,
applying the rules of statutory construction, concluded that
the EITC and child tax credits were intended to be included.
It similarly found that the credits could not create a
negative tax for these purposes based on Sec. 6211(b)(4) and
the rules of statutory construction.

The majority
opinion also invoked the rule of lenity, which requires that
statutes that impose a penalty be interpreted in favor of more
lenient punishment.

In a dissenting opinion joined by
two other judges, Judge David Gustafson objected to the
conclusion that the amount shown as the tax by taxpayers on
their return should be reduced by credits that the taxpayers
admitted they did not qualify for. In his opinion, the tax
shown on the return, for purposes of Sec. 6662(a), was the
$144 tax actually shown on the return.

The dissenting
judges concluded that, because the taxpayers showed a total
tax of $144 on their return, there was no underpayment under
Sec. 6664(a) and, thus, no penalty could be imposed under Sec.
6662(a).

With all the recent tax law changes, this year it’s more important than ever to make sure your clients’ tax situations are squared away before year end. This report provides necessary guidance to ensure 2019 starts without a hitch.

Don’t get lost in the fog of legislative changes, developing tax issues, and newly evolving tax planning strategies. Tax Section membership will help you stay up to date and make your practice more efficient.